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"If you can meet with Triumph and Disaster, and treat those
two strangers just the same" ... Rudyard Kipling

Problematic Pronouns

We all probably know someone
who believes that their successes are entirely down to their own
levels of skill and whose failures are someone else’s fault. To
some extent most of us will meet them in the mirror each morning.
This is self-serving
bias in action.
As Donelson Forsyth explains it:

“Those told they failed attribute performance to such external
factors as bad luck, task difficulty, or the interference of
others, and those told they succeeded point to the causal
significance of such internal factors as ability and effort.”

Now, what do you think will happen to a corporation if you put
someone with a bad case of self-serving bias in charge? Beware
the CEO with a bad case of the personal pronouns, that’s what I
say. And let's not talk about global warming.

“In the US sample 93% believed themselves to be more skillful
drivers than the median driver and 69% of the Swedish drivers
shared this belief in relation to their comparison group. “

Generally we have an unduly positive image of ourselves, and we
gravitate towards activities at which we’re naturally good,
rather than those which we’re bad at; which reinforces our
self-perception. Self-serving bias (otherwise known
as self-serving attribution bias, or SAB) would
seem to arise quite naturally from this bias to the positive.
And, frankly, given all the crap we have to put up with most of
the time if we don’t believe in ourselves we’d probably drown in
misery.

Normal, Sad and Dangerous To Know

Unfortunately a perfectly
natural bias to the positive gets taken to the extreme in some
people and people with a bad case of self-serving bias are quite
dangerous to be around. One piece of research, by Theo
Offerman, Hurting
Hurts More Than Helping Helps, suggests that people with a positive
self-image will respond less favorably to someone being nice to
them than you might expect:

“After all, someone as nice as yourself deserves to be treated
well.”

But, of course, this effect is reversed if someone is nasty to
you. In fact subjects are much more likely to reciprocate
an intentionally hurtful action than an intentionally helpful
one. And the key is intentionality – people with a strong
positive self-image really, really don’t like being mistreated.

Believing in
Yourself

Of course, if most people
are afflicted by self-serving bias then most investors will also
be, and the tendency to attribute our investing successes to
skill and our failures to the incompetence of management or some
other ethereal force has long been attested to. For
instance, in Investor
Psychology and Market Under- and Overreactions the authors note:

“The confidence of the investor in our model grows when public
information is in agreement with his information, but it does
not fall commensurately when public information contradicts his
private information. The psychological evidence indicates that
people tend to credit themselves for past success, and blame
external factors for failure”.

Applied to stock market trading this has several disconcerting
implications, because if we believe our triumphs are the outcome
of our own efforts and our failures the result of unavoidable
external interventions we’re never going to learn – we’re
blocking our own feedback paths, and feedback is critical to
improving investment performance (see: Depressed Investors Don't Need Feedback. Everyone
Else Does). We would expect such beliefs to tend to
lead to over trading and as we’ve seen overtrading leads to
underperformance. However, the implications go beyond this,
as Simon Gervais and Terrance Odean point out in Learning
to be Overconfident:

“In times when aggregate success is greater than usual,
overconfidence will be higher … In many markets returns will be
a trader’s metric of success. Traders who attribute returns
from general market increases to their own acumen will become
overconfident and therefore trade more actively.
Therefore we would predict that periods of market increases
will tend to be followed by periods of increased aggregate
trading.”

Shocking, ain't it?

CEO SABOf course, this result is
intuitively obvious. Fortunately, given that human
intuition is about as reliable a guide as a compass in a
cyclotron, there’s some empirical evidence to support the
idea. Most interestingly the model goes on to suggest that
we’re more overconfident early in our investing lifetimes –
experience does reduce this effect, as we saw confirmed
in Investor Decisions - Experience Is Still Not
Enough (But It Helps A Bit).

However, behavioral biases don’t stop at one level, they afflict
us all, no matter what position we hold. Just as
self-serving bias impacts us in ordinary life and as investors it
will also afflict us at work. And when your job happens to
be as a chief executive of a major corporation this can have
consequences for more than you and your immediate
family.

In a neat study, Managers’ Self-Serving Attribution Bias and
Corporate Financial Policies, Feng Li looks at how and when
CEO’s use the personal pronoun “I” in 10-K filings. The
finding is unsurprising at one level – when times are good
executives are quick to promote themselves, and when times are
not so good they’re rather more likely to retreat to use of the
third-person. Heads I win, tales they lose. However,
the implications are rather graver than the sloping of well
padded corporate shoulders. Let me quote at length:

“Consistent with this argument, managers with more SAB
[self-serving bias] are more likely to issue forward-looking
statements and make earnings forecasts, the tone (e.g.,
positive versus negative) of their forward-looking discussions
has smaller variation, and their earnings forecasts tend to be
overly optimistic. Firms whose managers have more SAB have
higher investment-cash flow sensitivity and experience more
negative market reactions around acquisition announcements.
These firms also tend to have higher leverage, rely more on
long-term debt financing, are more likely to repurchase stocks,
and are less likely to issue dividends.”

On a slightly more positive note Andy Kim in Self-Serving Attribution Bias and CEO
Turnover suggests that CEO’s with bad cases of
self-serving attribution bias are more likely to get fired.
Even the market response to these executives appearing on
CNBC is
generally negative, so not all media exposure is bad.

Climatic Penury

From all of which we can roughly conclude that people who aren’t
very good at accepting the blame are not good for us personally
or as investors. However, because this is an
all-encompassing bias it can appear in all sorts of places: we
even find this in national attitudes to who should bear the costs of mitigating climate change – a
difference that appears to mirror the current impasse in
negotiations, and probably reflects the impact of self-serving
bias on the negotiators.

Of course, we can’t attribute all of the woes of the world to
self-serving bias, but the idea that what’s good for us is fair,
that our successes are always the result of our innate skill and
that our failures are inevitably caused by evil outside
intervention is a dangerous one for investors. For us the
proper state is to be egoless; willing to recognize that triumph
and disaster are strangers we should treat just the same.

In investing, as in life, dogmatic persistence with a particular
approach is a good thing right up until it isn’t. Very many
very rich people have got that way by believing in themselves and
ignoring feedback – but unfortunately these are just the ultimate
result of survival bias. If everyone gambles constantly
someone will fluke a fortune. Following these “successes”
is a one-way ticket to penury. Better take the long
reflexive way home. You may not end up filthy rich, but at
least you won’t end your days chasing hubcaps for a crust.